We provide the gist of imp points to be used before picking a stock
for long term investment.
History of the company: This is the starting point of every research on a
company. A sense of history is vital before embarking on work related to the future. What you are looking for are details on business infrastructure, vision and values, company ownership details, the composition of the board and basic financial and stock market performance of the company.
Business mode: If a company's business model is not understood, any investment in its stock is tantamount to speculation. Every investor should know how a company earns money. What you are looking for is if it is a
product or service company, if it has domestic or global customers, what is its business mix and how does it add value to products/services. In simple words, one should be able to describe the business in your own words.
Is the company profitable: The main objective of any company is to
optimise returns on capital employed. The first step in this process is to
be profitable i.e. earn return on capital higher than the cost of capital.
Or at least achieve it in the near future. What you are looking for is a
return on equity greater than the cost of equity. Motilal deems companies
to be profitable only if their RoEs are consistently higher than 13%.
Terms of trade and cash flow: The need here is to assess whether the
company has reasonable bargaining power with its customers and suppliers
and if its profit is stuck in working and fixed capital. What you are
looking for here are businesses with a favourable low debtor-creditor
ratio, companies with healthy and preferably rising operating cash flows
and nil sustained negative free cash flows.
Cost and margin structure: This can help an investor get a grip on the
past cost and margin structure, and changes in the same. The same can be
used to estimate future margins. What you are looking for is the long-term
trend of costs and margins using common-size analysis. In common-size
analysis, sales of a company are set to 100 across years. Then all other
heads of cost and margins are presented as a percentage of that 100. This
can show a good trend of costs and margins over the years.
Du Pont Analysis: The objective of Du Pont Analysis is to generate
granular insights into the most important business metrics – namely, RoE.
Under this, RoE equals PAT margin multiplied by asset turnover multiplied
by leverage. What you are looking for is the long-term trend of the three
components of RoE – profit margin, asset turnover and leverage.
Competitive landscape and regulation:This is the first checklist which is
external to a business. But it is arguably the most important one, as the
level of competition and regulation in a sector can make or break the
fortunes of players in that sector. What you are looking for are key
competitors, if the product/service is globally tradable, threat of new
entrants and if there is heavy regulation.
Economic moat: This is to ascertain whether a company can sustain its
profits and profitability amidst strong competitive forces. An economic
moat protects a company's profits from being attacked by a combination of
multiple business forces. In traditional management theory, terms such as
'sustainable competitive advantage' or 'entry barriers' essentially connote
the idea of an economic moat. What you are looking for is a company's
ability to keep competitors from nibbling away its profits.
You can check our Short Term Investment tips here.
